A common problem our silent revolutionaries face is that they don’t know how to calculate if their new (or reengineered) sales functions are making them money.
A worse problem is that they think they know but end up massively under-estimating their performance.
Consider this scenario.
It’s the end of your calendar year.
This year, you started work building a new (inside) sales function. You added a couple of salespeople in March. A couple more in June and a couple more in September. Over that period, you’ve navigated a number of steep learning curves. You’ve had to learn how to generate effective campaigns. You’ve had to learn how to teach salespeople to function in this strange new environment. And, most importantly, you’ve had to learn how to ramp-up sales activity to at least 20 meaningful selling interactions, per salesperson, per day.
Your board would like to know if you’re making money yet. Simple request right? So, you’re sitting down with your financials (specifically, your profit-and-loss report), trying to figure it out.
I’m guessing you see the problem, here. There’s no way that you can extract the performance of your nascent sales function from your profit-and-loss report.
It’s impossible. Any attempt will yield an answer that’s precisely wrong (rather than vaguely right). Worse still, the error is highly likely to under-report the viability of your sales function.
The primary reason is that you’ve incurred greater costs during this start-up period than you would expect to incur in future years but you’ve booked significantly less revenue because, over that period, you’ve been opening an ever-increasing number of sales opportunities, many of which are still to close.
Another reason is that normal variation in your top-line numbers is likely to be disguising the performance of your nascent team. (More on that here.)
One thing I’ve learned over the last 20 years or so is that attempting to solve impossible problems is not a productive endeavor. So, if you’re in this position right now, my advice is to throw away your profit-and-loss report and return your high school calculus and statistics textbooks to the bookshelf.
Interestingly, it’s not that difficult to provide your board the numbers they’re looking for (there’s no integral calculus required). But it may require you to think a little differently.
Specifically, you need to do some forensic accounting and calculate the unit economics of a single hypothetical (and representative) salesperson.
Unit economics means that you’re going to ignore the business as a whole and focus (in this case) on a single (inside) salesperson. In turn, this means that you’re going to do your calculations on a purely marginal basis (in other words, you will not attempt to allocate any operating expenses).
What you need to estimate is, the monthly contribution that a single (average) salesperson will make to the profitability of your business, once the sales function is operating efficiently and once that salesperson has come up to speed.
You’ll have to make a number of assumptions to estimate this number. And you’ll have to dig for information in your transactional data to support these assumptions.
Let’s start with the conclusion and work backward, to discover how this is done:
- The monthly contribution that a salesperson makes is the difference between the Throughput (or contribution margin) they generate and their salary cost.
- Throughput is the revenue booked, minus totally-variable costs (typically raw-material and delivery costs only) and grossed-up to account for any future business that is likely to flow directly through your customer service team as a result of the salesperson’s deals.
- Of course, the Throughput generated by a salesperson is a consequence of the opportunities they process each month. Some will be won. Some lost. So, you should calculate the average Throughput for a won opportunity and then discount this number based on your assumed win/loss ratio.
- Once you know the average Throughput per opportunity, you can multiply this number by the number of opportunities you expect a salesperson to process in an average month, and then subtract your salesperson’s salary cost.
Once you have estimated a salesperson’s average monthly contribution it’s easy to estimate the performance of your new team (once the dust has settled) and to project the consequences of adding still more salespeople (or making changes elsewhere in the process)
This is the information that you and your board need to make smart decisions. If your board objects that your numbers are based on a number of questionable assumptions, then don’t back away from that. They are right. Reality is uncertain and messy.
Remember, it’s better to be vaguely right than precisely wrong.
A salesperson’s contribution: sample calculation
Here’s a practical example of the calculation described above (working forward this time, rather than backward).
- Let’s assume that the (up-front) revenue generated by a salesperson’s average sale is $4,500.
- Let’s assume that the totally-variable costs associated with this sale are 35%. This means that each sale generates $2,925 in Throughput (or contribution margin).
- Let’s assume that an average sale results in follow-on transactions that flow directly through customer service, worth roughly 5 times the value of the initial transaction. So, after grossing-up our Throughput to account for future transactions, we have a new Throughput number of $14,625.
- Sadly, a salesperson’s unit of work is a sales opportunity, not a sale! We’ll assume that our salesperson wins about 3% of their opportunities. This means that each opportunity processed generates an average of $439 in Throughput.
- We’ll assume that our salesperson has 20 meaningful selling interactions a day. This will result in them processing (winning or losing) about 10 opportunities daily. This means that they are generating $4,390 in Throughput a day, or $87,800 a month.
- We’ll assume that we pay our inside salesperson a fully-loaded salary of $100,000 a year, or $8,330 a month. This means that our salesperson is generating a contribution of $79,470 a month.
Obviously, if your numbers look anything like this, you will be keen to scale your inside sales team as fast as your cashflow will allow.
But consider the implications if, rather than doing this analysis, you were simply to look at your profit and loss report and conclude that you are less profitable this year than you were in the preceding one and that, consequently, you should shut down your nascent inside sales team!
I wish I could say that this never happens.